There is a direct correlation between the expectation gap and the tax adjustments required or authorised by tax legislation. This fails to distinguish between tax adjustments which are ‘fair’ and those which are ‘unfair’. It also fails to include any ‘unfair’ actions that reduce taxable profits and accounting profits.

The following diagram shows the relationship between various elements:

As you can see, the entirety of the ‘unfair’ behaviour is not captured by the expectation gap, as it does not include suppressed profit. This is a false negative result for ‘unfairness’.

Furthermore, the total amount of ‘fair tax adjustments’ is included in the expectation gap. This is a false positive result for ‘unfairness’.

Where ‘fair tax adjustments’ increase taxable profits, true positive results for ‘unfairness’ can be hidden as the expectation gap becomes negative (ie more tax is paid than ‘expected’):

The only circumstance in which the expectation gap is necessarily of relevance is where ‘fair tax adjustments’ are nil or insignificant.

However, FTM are using the expectation gap to measure ‘fairness’, which means that the method treats all tax adjustments as ‘unfair’.

UK rate of corporation tax

It is hard to see why it is considered that the UK rate provides a reasonable approximation of what a multinational group’s corporation tax ‘should’ be. This is particularly true given its rapid reduction from 30% towards 20% which provides an inconsistent benchmark for companies with significant profits in other jurisdictions.

Under our existing system of international taxation, or any other proposed system of international taxation, profits of a group will be taxed at different rates according to which jurisdiction those profits are allocated to.

The UK statutory rate is therefore not necessarily an appropriate rate of tax to be used as a benchmark for any multinational entity, regardless of what is considered to be a fair means of allocating profits.

The appropriate rate will depend on the individual circumstances of the group.

This is not about getting a ‘correct’ answer but providing a stable benchmark for comparison between entities. FTM should not be used to analyse multinational entities until it can provide some mechanism to allow for profits being fairly taxed at different rates.

Overall assessment of expectation gap method

The level of analysis is far too basic to assess any entity’s behaviour. It would be inappropriate to use the method to assess the behaviour of an entity entirely taxed in the UK. The assessment of multinationals using the UK rate further confuses issues.

An entity that scores badly may be acting in an entirely proper manner. And an entity that scores well may be acting in an improper manner.

The FTM ‘fair tax score’ provides no assurance of fair, or unfair, behaviour with regards to corporate taxation.

2. How might we improve on the methodology for UK multinationals as it stands? For example:

Would you add/ remove criteria? If so, why? Have you others to add?

Do you agree with our calculations?

I would completely remove the ‘fair tax score’ element.

I don’t agree with the calculations. There are fundamental flaws in the maths, as I have pointed out elsewhere, but these are relatively minor issues compared to the expectation gap issue. In brief:

The annual weighting is incompatible with the assumption that timing differences even out over six years. That assumption in itself is incredibly flawed. It is not safe to simply assume that timing differences will even out over six years, or any other length of time.

FTM need to analyse deferred tax and account for it in the calculations somehow, especially if it wants to use any form of annual weighting. However, if the same level of analysis on current tax is maintained, there will be little point.

What FTM call the ‘sum-of-the-digits’ method, is completely inappropriate for calculating the average of current tax rates. Current tax rates can be very misleading when tax adjustments are significant compared to profits.

3. How might we extend our methodology to rank foreign-owned multinationals operating in the UK?

I think that the methodology is unsuitable to be extended at this time. I suggest releasing a draft methodology for comment.

4. How might we extend our methodology to work with medium-sized UK companies? Country-by-country reporting is obviously less of a factor here but many more domestic issues come into play such as employee renumeration and benefits, the use of dividends to avoid tax, VAT and stamp duty avoidance whilst related party transactions and even tax havens remain an issue.

The fact that these factors are not assessed at all is a significant problem for assessing multinationals and large entities too. This is another issue that must be addressed.

I think that the methodology is unsuitable to be extended at this time. I suggest releasing a draft methodology for comment.

2 Responses to Fair Tax Mark consultation response

The only thing I’d add is that in my mind “unfair tax adjustments” can also increase taxable profit above the accounting profit. For example, the lack of tax relief for commercial property means a big add-back of depreciation, which may or may not be taken into account in a future capital gains calculation – I’d argue that this is unfair, though of course it is fully intended by statute.

That is, “unfair” can mean that the company is being treated unfairly, just as much as it can mean that it is acting unfairly, and this gets lost from the analysis.